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Three Japanese net-net's compared

After my last post reviewing the book Investing in Japan I figured it was only appropriate to highlight a few Japanese companies.

I'm working my way through a list of Japanese net-net's again and I'm scoring them against a simple criteria:

10 years of positive EBIT

10 years of positive net income

No debt

Pays a dividend

Shares decreasing or stable

I know this seems really strict, but believe it or not out of 100 or so companies that passed a strict net-net screen I'm getting companies that match the above criteria. Because my approach to Japanese net-net's is mostly mechanical in nature I want the best possible companies I can find. I'll leave the turnarounds and special situations for a Japanese equities specialist. I just want to find cheap companies that should be mean reverting.

I am going to do this post a little different than most, I want to go over three profitable net-net's. I will give a short business summary and background, and a look at the balance sheet through my net-net template. I'm also going to use this post to roll out something new, a Japanese net-net comparison spreadsheet. As I look at these companies I'm compiling some relevant metrics into a big spreadsheet so I can compare over a variety of data points.

I know it seems a bit ironic that after doing a post on how stocks are businesses I'm now posting financial details on three Japanese companies with a focus on financials and not the actual business. The reality is when looking at net-net's in Japan I'm taking a bit of a quant approach. I don't read/speak Japanese, I've never been there, I don't understand the culture, so the best I can do is make a judgement based on some numbers. Without further ado:

Ryoyo Electric (8068, last trade ¥939)

Ryoyo Electric is a semiconductor company, seems like most cheap stocks are these days. The company has three segments, integrated circuits, application specific circuits, and large scale integration circuits. Ryoyo's products are a commodity and they end up being a price taker so they're subjected to the whims of the market. The company is located in Tokyo.

Highlights

Net cash company if you include long term investments, ¥950/sh

Negative cash flow one of the last five years.

Tokyo Exchange

Debt free

EV/EBITDA of 1.73

NCAV of ¥2183

NWCC of ¥1770

Choukeizai Sha (9476, last trade ¥340)

Choukeizai Sha is a book publishing company, they publish five magazine subscriptions and over 450 throughout the years. The books mostly related to economics, management, law, accounting and tax related subjects. I realize the publishing industry isn't the best right now but this company is trading at an absurd valuation.

Highlights

The company has been profitable the last ten years.

Positive cash flow and FCF for the past five years.

ROE ex cash of 10%, the overcapitalization is penalizing the business.

Osaka traded

Debt free

NCAV of ¥813

NWCC of ¥677

Net Cash ¥395, slightly above the last trade.

Shinko Shoji (8141, ¥715 last trade)

Shinko Shoji is a small cap exporter of electronic components, they import components from abroad, assemble them and then resell them internationally. They sell memory chips, LCDs, semi-conductors, capacitors, and complete PC systems.

Highlights

While posting a positive EBIT and positive net income for the past 10 years the cash tells a different story. Cash flow is lumpy with big years ¥6b yen, and then years of ¥7b losses.

Capex requirements appear to be very minimal.

Tokyo listed (easier purchase for some investors)

Sizable dividend yield above 4%.

Paltry net margin

NCAV ¥1395

NWCC ¥806

Comparison Spreadsheet

Here are the three companies compared, I plan on adding to this spreadsheet as I research more Japanese net-net's. I'm guessing of the original 100 companies I'll end up researching 10-15 and maybe purchasing 2-5, we'll see how it turns out.

15 comments:

I would tend to agree with the comment below that one should not use a broad brush when examining Japan's macro or demographic situation. However, I still think this is one country where one would want to be especially selective on stocks and definitely not use an index fund. Finding those that are perhaps more focused on the domestic market then exports and serve a certain niche of the Japanese population would be key.

I found your blog recently by random and have been browsing it since - certainly good stuff.

Personally I'm have been looking "net-nets" from the Nordic market (Denmark, Sweden, Norway, Finland) latelly but with thin results. Few of them here and there but, according to my analysis, mostly cash burners.

Maybe I should widen my research to other markets too, like Japan. Worried about the cultural, informational and distance issues, though.

Thanks for the comment. I have one post on a Nordic net-net Rella Holdings: http://www.oddballstocks.com/2012/01/rella-holdings-profitable-company.html

I haven't looked up there much but I'm interested in that market for sure. The Nordic countries seem to have avoided the worst from the recent crises.

I think there's a lot of value in Japan right now, but yes there are some issues you'd need to understand at first. My search for cheap companies had me leaving my home market as well (the US), there just aren't as many net-net's in the US as there are worldwide.

I did a quick valuation excersie with Ryoyo with EVA-model (or residual earnings if you are familiar with Penmans valuation text book).

Results (mil. yens):

Assets in operations (ex. some cash+investments):43 026

Liabilities:8 437

Net assets used in operations:34 589

Income from opertions(excluding random and non-operating entries):808

RNOA (return on net assets=ROI=return on invested capital):2.3 %

If your required returns for operations are about 10 %, this company is clearly destroying value (EVA about -3000 in a year).

According to the EVA model the resultin value for operations would be about 5 000. Given that ther is net investment of 34 589 in operations this is not very good results.

If you add the extra cash and investments (27 572), the resulting equity value is about 33 000 which makes equivalent of about 1000 yens per share.

It seems to me that if the company continues as going concern the stock is roughly correctly valued.

If the company would quit its operations now, it would be clearly more valuable (say twice).

So my question is, as I have no background in this "net-net" investing and only recently have got known to it from this blog on one other (Geof), how do you expect unlock the value from this?

Company's history tells that the operations have been in same condition for years and there is no indication of any improvement (at least after few hours of research), stock price has been basicly at the same level for years too, and certainly it seems that the company is not liquadting either.

-Epa

ps. Keep up the good work. It is providing good information from net-net investing which I'm not very familiar with.

Cash+investments not needed in operations are 27 572 million yens (according to my estimate) equivalent to 925 yen/share. Company could share that amount of money to equity holders without any effect to operations.

Last closing share price 942 yens indicates that investor would get the operations for 17 yens/share. Earnings per share was 33 yens last year which makes tidy 0.5 P/E for operations.

1)you obiously added Ryoyo's longterm investments in the marketable securities numbers. Is that legitimate? I know that usually they are liquid, easily sellable and mostly marked to market on the books.

2.) concerning ryoyo's outstanding shares. Ryoyo bought back quite a lot of shares and immediatly canceled them in the end of 2011. As of the financial review of 2012 outstanding shares are now 26,6. Is that the number you took?Because I first used 28,8 Mio as stated at businessweek. I correcte it now to 26,6 and for sure it makes a hack of a difference.

1) I always add marketable securities into current assets due to the liquidity and the fact the company could unload them without affecting operations. Since this is liquidation value I think it's appropriate considering you'd probably get close to the holding value in a sale.2) I used the number of shares that MSN had, which was 27 million. So it looks like I split the difference between 26.6 and 28.8!

It's good to see the company buying back shares, especially since they're so undervalued.